Scoring Fairfax's digital gymnastics

Reading through the Fairfax annual report for 2012 it's clear that the Fairfax board and management want investors to take out one thing – the company is confident it is making the right moves to make Fairfax a power player in the digital age.

Considering this, two recent Fairfax moves are worthy of a closer look. First of all, the group sold its stake in New Zealand powerhouse Trade Me; and secondly it purchased the Australian venture capital/incubator business Netus, for an undisclosed sum.

Some have pointed out that Trade Me was an asset whose high growth days were probably behind it. This isn't true. Trade Me EBITDA reached $110 million for 2012 and revenue grew at 18 per cent, above and beyond the rate of digital advertising in Australia and significantly higher than the growth rate of digital display advertising. It has consistently shown a significant EBITDA return, delivering margins of 70-80 per cent. What's more impressive is Trade Me delivered its 2012 result with a cost base of $35 million – which is tiny compared to the high operating costs of other arms.

In comparison, Fairfax's broadcasting arm saw $13.9 million of EBIT in the 2012 financial year; New Zealand media $67.6 million; Fairfax regional media $159.1 million; AFR group $6 million; Metro Media's Transactions Group $31.3 million; and Metro Media $102.5 million.

After Trade Me, the best performing asset for Fairfax in terms of costs to EBITDA is the Metro Media Transactions Group. The last financial year saw a margin of 42 per cent off revenues of $72 million, revenues that had grown 24 per cent year-on-year. Despite a 30 per cent increase in costs year-on-year, the cost base is low relative to the rest of Fairfax. The Metro Media Transactions group is basically a collection of very strong digital assets – RSVP, Stayz, Domain, Drive, My Career, InvestSmart and Australian Property Monitors – with little or no reliance on display advertising. It is well led by Nic Cola, considered to be one of the top digital executives in the country.

In terms of digital sophistication and accomplishments, my belief is the market woefully underestimates Fairfax. As Greg Hywood pointed out in August, the Metro group (which excludes Trade Me) delivered $250 million of digital revenue in 2012. Its acquisitions in the transactions space have delivered strong results – in particular the RSVP and Stayz businesses, both clear leaders in their categories, and within the classifieds categories of auto, jobs and real estate it has greatly improved its offering and is demonstrating strong innovation across emerging mobile and tablet screens. The core masthead digital assets still reach significant numbers nationwide across all devices and the group is a leading player within the digital advertising space. Fairfax is not the backwards digital klutz it is often portrayed as. Far from it.

Given this, the Netus acquisition is a surprising one. It could be argued that since its inception, Netus has failed to deliver a digital success story that can rival any of Fairfax's.

The Sydney based VC/incubator, led by Daniel Petre and Alison Deans, has made nine investments since inception. Two of these came as part of the Fairfax deal – the content business Allure Media and a share in video ad network The Video Network. Allure has pursued a licensing approach, licensing overseas brands for usage in Australia and its brands Gizmodo, Lifehacker and Kotaku are owned by New York's Gawker Media; with Sugar and Shopstyle owned by the Californian based Sugar Inc. These brands are strong, niche technology and fashion/lifestyle players and can compliment existing Fairfax assets in these areas but they don't offer Fairfax anything unique, only add to areas it is already reasonably strong in.

The Video Network is a digital video ad network, selling ad space generally in the form of 15 and 30 second TVCs on content produced by external parties. Generally the end play for these sorts of businesses is a sale to a larger global ad network – such as an Adconion or even Google – as it becomes harder and harder when these spaces mature for domestic companies to compete in what always becomes a low margin, high volume intermediary business. The Video Network has quickly carved out a nice ad sales-led business capitalising on the media agency appetite for digital video, but like Allure it is unclear what it brings Fairfax that it doesn't already possess. Plus, TVN is unlikely to be incorporated into Fairfax and most likely will continue to operate as a stand-alone business.

It's also entirely feasible the other investors in TVN would look to buy back the Netus stake in the interests of simplifying a future sale. Both Allure and TVN are unlikely to add anything more than 5-8 per cent to the Fairfax Metro Digital advertising revenue figures ($162 million in 2012).

With that in mind, Netus must be a talent acquisition. In purchasing Netus Fairfax gets access to Petre and Deans and bolsters its digital credentials. It would not be out of the question for Petre to potentially join the Fairfax board, which has zero digital expertise (despite strong and experienced digital operators elsewhere in the business – in particular Metro chief executive Jack Matthews, transactions division chief Nic Cola and Metro Media commercial director Ed Harrison). Petre helped the Packers build out their digital footprint via eCorp in the early 2000s and has served on the board of PBL amongst others.

Meanwhile, the Netus investment record across businesses such as Downstream, Reach Local and Our Deal delivered the firm a respectable return, but it could be argued that Netus has not had a success story that can rival any of Fairfax's recent digital wins both in scale and return. The Netus model of licensing an overseas brand and selling back to them within three to five years, or low cost replication of a successful model elsewhere, appears an odd fit for Fairfax. Granted, Hywood has stated that cost containment is a key priority for the business, but a company like Fairfax that is attempting to develop a viable long-term strategic direction seeking to quickly scale then sell opportunistic digital businesses seems unusual.

Time will tell. Can Fairfax take some of the proceeds from the Trade Me sell off and either build or acquire another business that can offer it the same margins and profit? And can the recently acquired Netus team deliver Fairfax a bunch of digital success stories that can rival, or even be superior, to the digital successes Fairfax has already achieved? Can either the Netus team or the cash help revitalise the AFR group and the dire broadcast business? Can Fairfax lower costs in the core Metro Media business and find a successful model to extract revenue from news and content outside of advertising?

And if the Netus deal is about people and access to expertise that can drive the future of the business, has the Fairfax board looked externally for something it has a glut of internally?